BSAR - The Conceptual Framework - Moving Averages

1. What is meant by Moving Average?
• A Moving Average is an indicator that shows the average value of an assets price over a period of time
• When calculating a moving average, a mathematical analysis of the asset's average value over a predetermined time period is made.
• As the asset's price changes, it's average price moves up or down
• For example, a picture of a stock's moving average along with its price is below (SBI's 50-day moving average):
2. What are some different types of moving averages?
• Simple Moving Average
• A simple, or arithmetic, moving average is calculated by adding the closing price of the security for a number of time periods, say 20 days, and then dividing this total by the number of time periods, like 20 in our case.
• The result is the average price of the security over a time period
• Simple Moving Averages give equal weightage to each price element
• Exponential Moving Average
• An Exponential (or exponentially weighted) moving average is calculated by applying a percentage of today's closing price to yesterday's Moving Average Value
• Exponential Moving Averages place more weight on recent prices
• Because most investors feel more comfortable working with time periods rather than with percentages, the Exponential Percentage can be converted into an approximate number of periods.
• For example a 10% Moving Average corresponds with 9 periods Exponential Moving Average { Exponential Percentage = 2 / ( Time Periods + 1) }
• Triangular Moving Average
• Unlike Simple Moving Average, which gives equal weight to each price element and Exponential Moving Average which gives more weight to the recent price elements, Triangular Moving Averages give more weight on the middle portion of the price or data series.
• They are actually Double Smoothed Simple Moving Averages
• They are chiefly used in Oscillator Signal Lines, e.g., Slow Stochastics (5,3,3) uses 3 period Simple Moving Average of the 3 period Simple Moving Average of the 5 period Stochastic.
• Weighted Moving Average
• A Weighted Moving Average is designed to put more weight on recent data and less weight on past data
• A Weighted Moving Average is calculated by multiplying each of the previous day's data by a weight.
• The weight is based on the number of days (periods) in the Moving Average
• For Example to calculate a 5 day Weighted Moving Average, the first day's close is multiplied by one and the second day's close is multiplied by two and so on, so that the 5th day's close is multiplied by 5
• Variable Moving Average
• A Variable Moving Average is an Exponential Moving Average that automatically adjusts the smoothing percentage based on the volatility of the data series.
• Rise in Volatility increases the sensitivity of the smoothing constant
• Sensitivity is increased by giving more weight to the current data
• Variable Moving Averages perform better than both Simple Moving Averages and Exponential Moving Averages, in rangebound as well as trending markets